Only an estimated 10 per cent of real estate businesses have a succession plan in place. Many default to the idea that when the time is right they will simply sell the rent roll, while others assume their kids will take over at some point. As John Knight explains, neither of these plans are in fact ‘plans’ unless you have wrapped around them a full succession and exit strategy.
Done well, a succession plan can deliver real value to both the incumbent and the successor – it has to be a win-win situation for both parties.
START PLANNING EARLY
I suggest that you need to have started your succession plan at least three to five years out from a potential exit date. This gives sufficient time to:
- Minimise tax by reviewing the legal structure and understanding the tax implications of a sale
- Prepare your rent roll for sale by checking your compliance and removing inefficiencies
- Maximise the value of your rent roll by showing good profitability and minimising risk
- Identify potential successors, whether from within or externally
- Market your business, however you decide to do this.
SALE OR TRANSITION?
Not every succession involves a sale of your rent roll – in fact, the most successful successions I have been involved with did not involve a sale of a rent roll to an external party in one transaction. I would urge you to also consider:
- Entity sale rather than rent roll sale; in some states this can result in material stamp duty savings to the successor
- Family generational transition, a very tax-effective way to transfer control if you have a family trust within your structure
- Manager or key person buyout, often involving the incumbent retaining some equity in the business or financing with vendor finance
- Rent roll breakup and offloading in parcels, with the idea of maximising the value realised – although this will result in an increased administrative burden
- A combination of all options; maybe a partial sale of the rent roll before selling shares in your company to family or management.
IS IT MORE THAN ONE TRANSACTION?
As rent rolls get bigger and bigger, the market for those who can buy the rent roll in one transaction is getting smaller and smaller.
Yes, there are the well-known big players in the market who may be able to afford to fund it in one transaction, but for someone to buy even a $1m rent roll they are going to need to have equity of around $400k available to make the transaction happen – and that’s before working capital.
The most successful successions I have seen:
- Started well before the exiting party has any urgency around an exit
- Involved the incumbent reducing their equity interest over time in a structured sell-down (say, 10 per cent a year)
- Required the incumbent to help the successor fund their purchase into the business, usually by allowing them to use security in the rent roll for debt but also to justify a higher price
- Knew exactly how the exit would work from a cash and tax perspective by modelling different scenarios in advance
- Documented the succession plan for all parties, including the valuation methodology to be used within the shareholders’ agreement.
Don’t know where to start with your succession plan? I’d suggest taking a simple, classic ‘Now, Where, How, Why’ planning approach. Where are you now? Where do you want to be – and when? How will you make that happen? Why do you want to sell? The ‘how’ is the hard bit because usually there are many options available, but the ‘why’ is important to make sure the incumbent has a planned life after their exit.